Inside the SEC Case Against Mozilo

He's the most public face of the housing bust, the former head of the nation's largest mortgage lender. But according to a complaint filed June 4 by the Securities & Exchange Commission, Angelo Mozilo, the co-founder and former chief executive of Countrywide Financial, was leading that most simple of stock swindles—the "pump and dump."

In its civil complaint, the SEC accuses Mozilo and two of his top lieutenants, former Countrywide Chief Operating Officer David Sambol and former Chief Financial Officer Eric Sieracki, of misleading investors about the risk underlying the billions in mortgages the company sold. The complaint alleges that Mozilo made $139 million in profit by exercising Countrywide stock options from November 2006 to August 2007, knowing all the time his ship was sinking. Countrywide, which was based in Calabasas, Calif., was swallowed by Bank of America (BAC) last year.

In a series of e-mails released by the SEC, Mozilo can be seen writing to Sambol and others that some of Countrywide's own loan products were "poison," "toxic," and that the company was "flying blind" in making some its more aggressive mortgages. Mozilo describes one type of loan made to borrowers with bad credit who put no money down "the most dangerous product in existence." The government also appears to have a star witness in Countrywide's former chief risk officer, John McMurray, who the complaint says warned Sambol and others that the company's nonconforming loans were twice as likely to default as loans Countrywide historically made. McMurray also recommended the company provide investors more disclosure.

Claims of "Reckless" Lending

"This is the tale of two companies," Robert Khuzami, director of the SEC's Enforcement Div., said in a statement. "Countrywide portrayed itself as underwriting mainly prime quality mortgages using high underwriting standards. But concealed from shareholders was the true Countrywide, an increasingly reckless lender assuming greater and greater risk."

Not so, says Mozilo's attorney, David Siegel, of the Los Angeles firm Irell & Manella. "The SEC's allegations are baseless," he said. "Mr. Mozilo acted properly and lawfully at all times." The stock sales, Siegel says, "were made under the terms of a series of written sales plans which were reviewed and approved by responsible professionals." Attorneys representing Sambol and Sieracki were equally dismissive. "The SEC has no case against David Sambol," says his attorney Walter Brown, a partner at Orrick, Herrington & Sutcliffe in San Francisco. "Countrywide's investors, bondholders, rating agencies, and the financial industry were all well aware that mortgage lending practices were liberalized at Countrywide and almost all other financial institutions." Added Sieracki's attorney, Nick Morgan of DLA Piper in Los Angeles: "Mr. Sieracki lost money just like all other investors. He did not sell, he purchased Countrywide stock."

Anticipation of a complaint against Mozilo had been bubbling since the mortgage market first began to collapse in 2007. To date, relatively few cases have been brought against major players in the mortgage meltdown. Last year, the Justice Dept. filed fraud charges against two former Bear Stearns fund managers whose case has yet to go to trial. In April, the SEC charged two former executives of American Home Mortgage with fraud. One of them agreed to pay $2.4 million to settle the charges. Justice and the FBI have task forces looking at mortgage fraud. "There will be more filings, everything from federal fraud cases to state complaints," says Michael Kraut, a former prosecutor now in private practice in Los Angeles.

Not a Slam Dunk

Attorneys with experience in white-collar cases say the SEC is shrewd in keeping its complaint against Mozilo, Sambol, and Sieracki focused, arguing that Countrywide told investors its mortgages were clean when they were actually tainted by risk. "Mozilo holds the company to be the Tiffany & Co. of the business, when in fact it's not," says Thomas Ajamie, an attorney with his own white-collar practice in Houston. That version of events will not be difficult to explain to a jury, lawyers say.

Among the biggest concerns for Mozilo, attorneys say, are comments he made internally in April 2006 about the company's pay-option ARMs, a type of loan where borrowers could choose whether to pay interest or roll part of their payment onto the principal of the loan. "It's just a matter of time that we will be faced with…much higher delinquencies," Mozilo wrote. In public conferences and earnings announcements, however, Mozilo defended the product as a "sound financial management tool for consumers."

However, that doesn't mean the government's case is a slam dunk. John R. Fahy, a former SEC prosecutor now in private practice in Fort Worth, says he was surprised the government didn't include any evidence the company was actually filing false quarterly and annual reports. "This is a disclosure case, and there's no allegation of inaccurate financial statements," Fahy says. "The defense is going to say the financials aren't false." He notes that the defense will also likely bring forward evidence that Countrywide discussed its disclosure levels with outside advisers.

Trail of E-Mails

It's also evident in the e-mails that the government released that Mozilo was concerned about the growing risk in the company's loans and wanted to cut back. "Whether you consider the business milk or not," he wrote to Sambol in April 2006, "I am prepared to go without milk irrespective of the consequences to our production."

But that's no excuse, says New York attorney Jake Zamansky, who has brought several fraud cases against Wall Street banks on behalf of small investors. "Mozilo's responsible for the disclosure," Zamansky says. "He should be held accountable."